More China restrictions loom as ASML posts upbeat Q2 results

ASML and the Dutch government are caught between a rock and a hard place now that the US is putting the squeeze on allies to further tighten their semiconductor export restrictions. If the Netherlands and Japan continue to allow their semiconductor equipment manufacturers ASML and Tokyo Electron (TEL) to service certain gear that’s already operational in Chinese fabs, the Biden administration is threatening to invoke a blanket ban, Bloomberg reported. The report spoiled otherwise upbeat Q2 results published by ASML.

The US pressure is likely the result of the apparent failure of existing measures to prevent China from making advanced chips. Huawei last year launched a smartphone powered by a 7nm-class system-on-chip and experts say that 5nm chips are within China’s reach using only DUV lithography. There are even reports of preparations for a ‘Chinese’ 3nm node, and innovations in materials and packaging may enable China to continue to go forward. It should be noted, however, that it’s unclear at what scale and yield Chinese fabs can produce advanced chips, calling their competitiveness into question.

China’s capabilities are in part made possible by the DUV equipment ASML legally sold and installed before export restrictions came into effect. ASML is still servicing these tools, although there are limitations in certain fabs. “We still have eyes on the tools, as we call it, so we’re still in the fabs of our customers. But there are limitations that for some fabs are more stringent,” Roger Dassen told analysts during the Q2 earning call, referring to the use of components that are subject to export controls.

Without proper service and repairs, the US reasons, fab equipment is bound to eventually become useless. Unable to procure new systems, China’s progress in manufacturing quasi-leading-edge semiconductors would therefore grind to a halt.

Jurisdiction

Of course, ASML’s tools aren’t the only ones needed (sub-)7nm manufacturing. Without access to EUV, Chinese chipmakers need lots of sophisticated deposition, etch and other equipment to perform the extensive multipatterning processes required to produce leading-edge chip features. Bloomberg previously reported that SMIC used gear from US firms Applied Materials and Lam Research to manufacture the 7nm Huawei chip with gear acquired before the 2022 ban.

But whereas US equipment manufacturers are already barred from servicing advanced equipment in China, ASML and other key non-US companies like TEL are not. The Netherlands and Japan have held off on implementing such a ban despite diplomatic pressure from the US. “We are pushing for not servicing these key components, so these are discussions we’re having with our allies,” Under Secretary of Commerce for Industry and Security Alan Estevez said ahead of a meeting with Dutch officials in April.

Continued pushback against US wishes might result in invocation of the so-called foreign-direct product rule (FDPR), with which the US claims jurisdiction over every piece of technology that contains or is manufactured using technology of US origin. It has been used before, to stop TSMC from supplying Huawei with advanced ICs and to expand Dutch export restrictions on DUV equipment announced last year. When it comes to semiconductor regulations, the US government tends to get what it wants.

During the Q2 earnings call with analysts – his first one at the helm - ASML CEO Christophe Fouquet declined to comment on what he called rumors.

Alternatives

There’s another factor at play here, and that’s the US semicon sector. Feeling shortchanged, America equipment manufacturers argue that “Chinese chipmakers have been getting around the need for US machinery by relying on equipment and engineers from other countries,” Bloomberg writes. This doesn’t apply to ASML, which has no US competition, but could refer to another Dutch company, ASM, among many other global semicon outfits.

But US companies don’t want Washington to use the FDPR either. Instead, they are pushing to expand criteria for the so-called unverified list, a framework requiring companies to obtain licenses to ship certain restricted technologies. Even if foreign companies wouldn’t automatically be added to the list, the policy change would signal that additional controls are never far away.

ASML has always been adamant about being able to continue to serve Chinese customers. Sales there more than quadrupled over the past decade, accounting for 29 percent of system sales in 2023. So far, export restrictions have had only minor impact on ASML’s sales in China, since the bulk of the Middle Kingdom’s semiconductor industry is focusing on mature technologies rather than high-end processors.

This, too, has been making policy makers nervous, however. Both the US and European Union are considering restrictions for legacy chips as well. Pointing to a huge demand increase for such chips globally, ASML strongly opposes that. “Individual countries may say, ‘We don't like what China is doing with chips.’ In that case, we recommend that governments build their own plants. Because it’s is not feasible to make manufacturing difficult for China without creating alternatives ourselves,” Fouquet recently told Handelsblatt.

Flat

The geopolitical tug-of-war overshadowed ASML’s Q2 results, which supported a slow-but-steady recovery from the downturn. “We currently see strong developments in AI driving most of the industry recovery and growth ahead of other end market segments,” Fouquet told analysts. Semiconductor inventory levels are “trending towards more healthy levels” and lithography tool utilization level is seeing “continued improvement.”

Driving growth is expanding application space for semiconductors, the coming upturn and geopolitically motivated construction of fabs. Together, they could make for a hectic 2025 in Veldhoven, for which ASML and its supply chain continue to prepare.

ASML reported sales of 6.2 billion euros in Q2, up from 5.3 billion euros in Q1 2024 and down from 6.9 billion euros in Q2 2023. Bookings came in at 5.6 billion euros, up from 3.6 billion euros in Q1 and 4.6 billion euros in Q2 last year. Q2 marked the start of bookings for the 2nm foundry node, with more to follow in upcoming quarters to support the production ramp starting about one year from now. The memory sector is still scrambling to manufacture enough high-bandwidth memory (HBM) used in AI chips. With this in mind, along with a backlog of 39 billion euros at the end of Q2, ASML is “nicely on track” to end up at least the midpoint of the 30-to-40-billion-euro 2025 guidance provided at the 2022 Investor Day, Dassen said.

ASML will narrow down the guidance range at another investor event next November. It still expects 2024 to be flat in terms of revenue.

Main image credit: ASML